INSOLVENCY

Question 1

3

INSOLVENCY OF SOLE PROPRIETORS
AND PARTNERS—BANKRUPTCY

Answer 1

If the sole proprietor or a partner can no longer pay debts when they become due, they have several voluntary options, including:
1. negotiating with creditors,
2. entering an individual voluntary arrangement, or
3. applying for bankruptcy. Alternatively, a creditor may present a creditor’s petition for bankruptcy, forcing the debtor into bankruptcy if certain criteria are met.

Question 2

2

Negotiating with Creditors

Answer 2

1. An individual or partner who owes more money than they can pay (the debtor) can approach a creditor and ask either for the debt to be reduced or for extra time to repay the debt.
2. However, typically such an agreement is not binding on the creditor, as there is no contract consideration given by the debtor to support the creditor’s promise to abide by the change in terms. Therefore, at any point the creditor could demand the full amount on the original payment terms.

Question 3

4

Individual Voluntary Arrangement

Answer 3

1. An individual voluntary arrangement (‘IVA’) is a negotiated agreement between the debtor and all of their creditors. The creditors each agree to accept less in payment than is owed them.
2. Procedure

(1) A debtor who wants to agree an IVA with their creditors must** take professional advice; the debtor cannot proceed alone. The debtor must find an insolvency practitioner** (that is, someone who is licensed to act on behalf of companies or individuals facing insolvency). The insolvency practitioner will draw up proposals and supervise the implementation of the IVA.

(2) Statement of Affairs and Application for Interim Order

(3) meeting of creditors

(4) Implementation of plan

Question 4

3

Statement of Affairs and Application for Interim Order
IVA

Answer 4

1. The insolvency practitioner will have the debtor prepare a statement of affairs and will apply to the bankruptcy court for an interim order.
2. Whilst this order is in force,no bankruptcy petition may be presented or proceeded with unless permission to proceed is granted by the court.
3. Additionally, no other proceedings or executions can be commenced against the debtor. This gives the insolvency practitioner a breathing space to try to work out what assets and liabilities the debtor has, and whether there is any likelihood of a successful IVA, without individual
   creditors sending in the bailifs and whittling away the available assets.

Question 5

3

meeting of creditors
IVA

Answer 5

1. The insolvency practitioner prepares a report advising whether there are any realistic proposals to offer to the
   creditors and whether it is worth calling a meeting of creditors.
2. If a meeting is called and at least 75% in value of the debtor’s unsecured creditors agree to the practitioner’s proposals, the proposals become binding on every ordinary unsecured creditor who has notice of the meeting, even if they did not attend or vote.
3. Preferential creditors (that is, employees owed holiday pay or wages due in the last four months) and secured creditors (creditors who have taken collateral to protect their debt) are not bound, unless they agree to the proposal.

Question 6

Implementation of Plan

Answer 6

The insolvency practitioner (now called a supervisor) oversees and implements the proposals. If the debtor fails to comply with the IVA or provided false or mislead-ing information, the supervisor or any creditor who is a
party to the IVA may petition for the debtor’s bankruptcy.

Question 7

2

Bankruptcy Definition
sole proprietor/partner

Answer 7

1.Bankruptcy is a judicial process in which the assets of the bankrupt debtor are passed to a third party, the trustee in bankruptcy, who liquidates the assets and uses the money from the liquidation to pay of as many of the debtor’s debts as possible in a strict order set out by legislation.
2. Once an application for bankruptcy is made, the debtor’s creditors must stop chasing after the debtor, and the debtor will be discharged from most of their debts after one year.

Question 8

3

Insolvency of a sole proprioetor and Partners
Procedure
An application for a bankruptcy order can be made in three ways:

Answer 8

1. The debtor can apply online to declare themself bank-rupt.
   The application is heard by an adjudicator appointed by the Secretary of State. The application will be granted if the adjudicator finds the debtor is unable to pay their debts;
2. One or more unsecured creditors who is/are owed at
   least £5,000 combined can present a petition for an order of bankruptcy to the bankruptcy court; or
3. The supervisor of an IVA can petition for the debtor’s bankruptcy if the debtor has breached the terms of the IVA, hidden assets, or given a preference to a creditor.

Question 9

official receiver
Bankruptcy for sole proprietor or partner

Answer 9

If the bankruptcy order is made, then an offcial receiver is appointed. The offcial receiver is a **civil servant **who will act as the trustee in bankruptcy unless the creditors seek to appoint their own nominee.

Question 10

2

Creditor’s Application
Bankrupcy

Insolvency of sole proprieter or partner

Answer 10

1.A creditor who applies to have the debtor declared bankrupt must prove that the debtor is insolvent (un-able to pay their debts) by showing either
(1) that the debt is payable immediately and the debtor does not have funds to pay, or
(2) the debt is payable in the future and the debtor has no reasonable prospect of being able to pay.

2. The creditor may use the following methods to make the necessary showing:
   (1) If the debtor owes a liquidated debt for £5,000 or more, the creditor may make** a statutory demand** for payment; if the debt is not paid within 3 weeks, or the debtor does not apply to set aside the statu-tory demand within three weeks, the debtor will be deemed insolven

(2) If the debtor owes a future liability of **more than **£5,000, the creditor may serve **a statutory demand for proof **of ability to pay; if the debtor does not show a reasonable prospect of being able to pay the debt when it falls due or apply to court to set aside the statutory demand, the debtor will be deemed insolvent.

(3) If the debtor owes a judgment debt of more than £5,000, the creditor can seek to execute on the judgment; if the attempt fails, the debtor will be deemed insolvent.

Question 11

Bankruptcy Estate
Sole proprietor/partner

Answer 11

The bankrupt’s estate vests automatically in the trustee in
bankruptcy. This means the bankrupt does not need to go through any legal formalities to transfer those assets. There is no need for them to complete a stock transfer form or the like.

Question 12

3

Exemption from the Bankruptcy Estate
sole proprietor/partner

Answer 12

1. The bankrupt is entitled to keep some assets needed for
   day-to-day living, such as furniture and any tools required for their job.
2. The bankrupt is also entitled to retain any salary they make, subject to the trustee applying for an income payments order, if the salary exceeds the amount needed for the reasonable needs of the bankrupt and their family.
   3.The payments order can last for a maximum of 3 years.

Question 13

Bankrupt’s Home

Answer 13

The bankrupt’s interest in their home will pass to the trustee, but there may be other legal or equitable interests in the home:
1. The home could be held in joint names;
2. A partner/spouse may have an equitable interest arising from a trust
3. A spouse may have a right of occupation under legislation; or
4. Children under 18 may live in the home, giving the bankrupt and their spouse/partner a right of occupa-tion.

If there are any of the above interests in the home, the trustee cannot sell the home without a court order, and
the court will consider all the interests before making** an order for sale**. However, after 1 year, the interests of the creditors are paramount, and so will take precedence over any of the other people claiming an interest.

Question 14

4

Restrictions on Debtor
During bankruptcy, in order to protect creditors, the bankrupt is restricted from certain behaviour. For example, the bank-rupt may not:

Answer 14

*Apply for credit of more than a prescribed amount;
*Act as a company director;
*Be a partner; or
*Trade under another name without disclosure of the bankruptcy.

Question 15

4

Order of Priority for Distribution to Creditors
The order of priority for distribution to creditors for a bankrupt is:

Answer 15

1) Costs of the bankruptcy;
2) Preferential debts (that is, holiday pay due to employees
and wages of employees due in the last four months and
HMRC in respect of VAT, PAYE, and National Insurance contri-butions owed);
3) Ordinary unsecured creditors; and
4) Postponed creditors (spouse or civil partner).
If there is not enough money to fully satisfy all the creditors at one level, then the debts rank and abate equally. This means all the creditors in that category will receive the same percentage of their original debt.

Question 16

End of Bankruptcy

Answer 16

If the bankrupt complies with the restrictions and has not
caused the bankruptcy by their own dishonesty, negligence, or recklessness, then the bankruptcy will be automatically
discharged after one year.**

Question 17

3

Culpable Bankrupts

Answer 17

A bankrupt who has caused the bankruptcy by their own dis-honesty, negligence, or recklessness is considered ‘culpable’ and can be subject to a court bankruptcy order for up to 15 years.

Question 18

3

What If an Individual Who Is a Partner Is Made
Bankrupt?

Answer 18

1. Partnership at will
2. partnership not at will
3. limited liability partnership

Question 19

3

Partnership at will

Answer 19

1. If the bankrupt person is a partner and the partnership is a general partnership at will, then, the partnership will be dissolved on the bankruptcy of the partner.
2. The trustee in bankruptcy (or liquidator if the insolvent partner is a company) will receive any money due to the insolvent partner, to be used for the beneft of the partner’s creditors.
3. A partnership at will arises if a partnership is formed for an indefinite term and there is no agreement preventing individual partners dissolving the partnership.

Question 20

2

partnership not at will

Answer 20

1. If the bankrupt person is a partner and the general partnership agreement provides that the partnership **will not **terminate on bankruptcy of a partner, then the partner-ship will continue
2. usually the remaining partners will purchase the insolvent partner’s interest from the trustee in bankruptcy (or liquidator if the insolvent partner is a company), in accordance with the retirement provisions in the partnership agreement.

Question 21

2

Limited Liability Partnership

Answer 21

1. An undischarged bankrupt cannot be a member or take part in the management of an LLP without the agreement of the court.
2. The trustee in bankruptcy will seek to realise the member’s interest for the benefit of his creditors, usually by selling the interest to the remaining members in accordance with the retirement provisions in the partnership agreement.

Question 22

If** a general partnership** is insolvent, the partnership is wound up using the same processes as for bankruptcy, if it is comprised of individuals, or for liquidating a limited company, if it is comprised of companies, or both if it is a mixture. The offcial receiver or insolvency practitioner will:

Answer 22

*Make sure all contracts are completed, transferred, or
otherwise ended;
*Cease the business;
*Settle any legal disputes;
*Sell any assets;
*Collect money owed to the partners or partnership; and
*Distribute any funds to the creditors.

Question 23

What If an LLP Is Insolvent?

Answer 23

If an LLP were to be made the subject of a winding-up order, it would be administered by the official receiver as a limited company, as discussed below.

Question 24

5

Insolvency Options for Companies
The options available for companies are:

Answer 24

1. Receivership: This enables** secured creditors** to recover what is owed solely to them
2. Restructuring plan: This allows companies to restructure their debts with the sanction of the court;
3. Moratorium: This halts most actions by creditors to enforce their rights;
4. Administration and company voluntary arrangements:These seek to rescue the company; and
5. Liquidation: This causes the company’s assets to be sold to pay of debts and the company will cease to exist.

Question 25

3

Fixed Asset Receivership

Answer 25

1. When a company borrows money, a creditor may take security over the company’s fixed assets, such as its equipment or plant.
2. The loan and security agreement between the company and the creditor will set out what comprises a breach.
3. It will usually also give the lender the right to appoint an administrative receiver if the company commits a breach. In the case of a breach, the receiver** takes possession of the asset** securing the loan (the ‘charged asset’) and (usually) sells it to pay the secured lender (the sale is not for the beneft of all the creditors).
4. Once the asset is sold, the receiver has no further role in the company.

Question 26

3

Restructuring Plan

Answer 26

1. A company or LLP that has encountered or that expects
   financial difculties may propose a **compromise **or arrangements with its creditors or members. Usually, the plan involves the creditors agreeing to accept less than they are owed but more than they would likely receive in bankruptcy.
2. The plan must be approved by those owed at least 75% in value of the unsecured debt.
3. The court may approve the plan even if one or more classes disagrees with it and the dissenting creditors will be bound (known as** a cram down)**.

Question 27

6

Moratorium

Answer 27

1. A company in financial distress may seek a moratorium which prevents creditors from taking action to enforce their financial rights or from commencing formal insolvency proceedings during the moratorium. (payment holiday)
2. Purpose
   The purpose is to rescue the company as a going concern and return it to profitable trading through a Company Voluntary Arrangement , a restructuring plan, refinancing, or an injection of new funding. A moratorium is not a formal insolvency procedure.
3. Procedure
   The** directors** of the company will appoint an insolvency practitioner as ‘monitor’ to oversee the company’s affairs and ensure that it is likely that the moratorium will result in a rescue of the company as a going concern.
4. To obtain the moratorium, the directors and the monitor
   file certain papers with the court.
5. The directors remain in charge of running the business.
6. A moratorium is not available for companies which are, or have within the previous 12 months been, subject to an insolvency procedure.

Question 28

3

Administration

Answer 28

1. Administration is a procedure which enables the **administrator **(an independent insolvency practitioner) to run, reorganise, and/or sell the company as a going concern.
2. This might enable the company to avoid going into liquidation. The aim of administration is for the administrator to (in order of importance):
   ***Rescue **the company as a going concern;

*Achieve a** better result** for the company’s creditors than would be achieved if the company were to be wound up;
or
*Realise property to distribute to one or more secured creditors.

3. The administrator acts in the interests of the creditors as a whole (unlike the receiver, above, who only acts for one secured creditor).

Question 29

4

procedure of administration

Answer 29

1.A company can go into administration by two methods:
*Through a formal court hearing; or
*By the company, its directors, or the holder of a qualifying floating charge fling certain documents with the
court.

2. If the court appointment is used, then the court can make the order only if it is satisfed the company is unable to pay its debts and that the order is likely to achieve a better resultfor the company’s creditors than liquidation.
3. The directors and the company (the members) can appoint an administrator if no winding up petition has been issued.
4. They must notify any qualifying foating charge holder who will agree or appoint an alternative administrator.

Question 30

2

Qualifying Floating Charge

Answer 30

1. A qualifying foating charge is a charge over the whole or substantially the whole of the company’s assets.
2. It will contain a provision empowering the lender to appoint an admin-istrator or an administrative receiver if a breach has occurred which allows the lender to enforce its security under the terms of the credit agreement (usually this is non-payment of interest or capital).

Question 30

4

Role of Administrator

Answer 30

1. The administrator must be a licensed insolvency practitioner.
2. They have the power to take control of the company’s property and sell it, bring or defend legal proceedings on behalf of the company, carry out the company’s business, remove or replace directors, and so on.
3. The administrator also has the
   power to investigate previous transactions of the company to seek to increase the value of the assets for the creditors and
4. can take action against the directors for wrongful and fraudulent trading.

Question 31

Moratorium Is Imposed to Restrict Other Insolvency Procedures under Administration

Answer 31

An advantage of administration is that a moratorium is imposed which: (i) restricts the ability of third parties to enforce their rights, and (ii) prevents the commencement of other insolvency procedures, giving the administrator breathing space to try to achieve the sale of the company as a going concern.

Question 32

3

Company Voluntary Arrangement

Answer 32

1. A Company Voluntary Arrangement (‘CVA’) is similar to an IVA; it is a compromise between the company and its creditors under which each creditor usually agrees to take less than the full debt owed them.
2. It is used when the company has a short-term cash fow problem but is generally fnancially sound.
3. Although the creditors might not be paid in full, they are likely to receive more money than if the company went into liquidation.

Question 33

4

Process for a CVA

Answer 33

1. The process is started by the directors of the company
   who make a written proposal to the creditors and nominate an insolvency practitioner to supervise the CVA.
2. As with an IVA, 75% or more in value of the unsecured creditors
   must agree to the CVA in order for it to be implemented.
3. If the CVA fails, the company could still end up in liquidation or administration.
4. As with an IVA, at least for small companies, it is possible to have a moratorium which restricts the ability of third parties to enforce their rights and prevents the commencement of other insolvency procedures which can give the company a breathing space.

Question 34

2

Voluntary Liquidation

Answer 34

There are two kinds of voluntary liquidation–members’ and creditors’.

Question 35

2

Members’ VoluntaryLiquidation

Answer 35

1. In a Members’ Voluntary Liquidation (‘MVL’), the
   members and directors control the process from start to fnish.
2. **It is available only if the company is solvent, but the individuals involved in run-
   ning the company wish to wind it up

Question 36

Creditors’ Voluntary Liquidation

Answer 36

A Creditors’ Voluntary Liquidation (‘CVL’) is started by the directors but then taken over by the creditors. Although it is voluntary, it will usually be commenced because the directors are advised that the company is insolvent and if they continue trading, they could be personally liable for the debts of the company through fraudulent or wrongful trading.

Question 37

Compulsory Liquidation of Company

Answer 37

A creditor who can show that the company is unable to pay
its debts can petition for the company to be wound up.

Question 38

Role of Liquidator
in Compulsory Liquidation

Answer 38

The liquidator collects in the assets of the company and distributes funds to the creditors in the statutory order and the company is dissolved.

Question 39

5

Order of Priority for Distribution to Creditors
The liquidator must pay back the creditors of the company in a set order:

Answer 39

1) Expenses of winding up (the liquidator’s and profes-
sional advisers’ fees);
2) Preferential debts (these are holiday pay due to em-
ployees and wages of employees due in the last four
months (up to a maximum amount), and HMRC in respect
of VAT, PAYE, and National Insurance contributions);
3) Debts secured by foating charges in order of priority
(subject to ring fencing (see below));
4) Unsecured debts; and fnally
5) Shareholders.
If there is not enough money to fully satisfy all the creditors at one level, then the debts rank and abate equally. This means all the creditors in that category will receive the same per-
centage of their original debt.

EXAMPLE
A liquidator has £25,000 remaining to pay unsecured
creditors totalling £100,000. Each creditor will receive
25,000/100,000 of their original debt. This is often referred to as receiving x pence in the pound. Here a creditor would receive 25p for every £1 owed. So, a creditor owed £5,000 would receive £1,250.

Question 40

6

CLAW BACK OFASSETS

Answer 40

1. The liquidator, administrator, or trustee in bankruptcy has a duty to the creditors and has powers to investigate the company or individual’s actions prior to the insolvency to maximise the funds available and to ask the court to set aside transactions that violate law, including the transactions discussed below.
2. PREFERENCE
3. TRANSACTION AT UNDER VALUE
4. Fraudulent trading
5. wrongful trading
6. setting aside a floating charge

Question 41

Preferences

Answer 41

A preference arises when a debtor does something that puts a creditor, surety, or guarantor in a better position on liquida-tion or administration than they would have been if the event had not occurred.

Question 42

2

Preference Must Have Been Intentional

Answer 42

1. For the event to be a preference, the company or individual must have desired to prefer the creditor, surety, or guarantor of the company.
2. However, the desire to prefer is presumed if the preference is in favour of** a connected person** (such as a director, their spouse, or other close family member or an associate of the bankrupt).

Question 43

Preference
Within Six Months

Answer 43

1. For an event to constitute a preference, it must have occurred within six months of the onset of insolvency (two years if the preference was made to a connected person or associate of the bankrupt).
2. For a company compulsory liquidation, the onset of insolvency is the date of presentation of the petition.
3. For a CVL, it is the date the company enters liquidation.
4. For administration, it is the date the company files a Notice of Intention to Appoint an Administrator or the date
   when it enters administration, whichever is earliest.
   5.For an individual, it is the presentation of the bankruptcy petition.

Question 44

CONSEQUENCE OF PREFERENCE

Answer 44

The transaction will be voidable at the discretion of the court. The court can order that any property be returned, any proceeds of sale be returned, or any security discharged

Question 45

2

Transactions at an Undervalue

Answer 45

1. A transaction at an undervalue arises when property that would have otherwise been part of the bankruptcy estate was given as a gift or was sold for signifcantly less than mar-ket value within two years of a company’s insolvency or five years of an individual’s bankruptcy.
2. The consequences of an undervalue transaction are the same as those for a preference

Question 46

2

Insolvency Requirement
For a transaction to be set aside (or otherwise remedied) as an undervalue transaction:

Answer 46

(1) for a company, it must have been insolvent at the time of the transaction or become so as a result, but there is a presumption of insolvency if the transaction is to a connected person.

(2) For an individual, there is no requirement to prove the debtor was insolvent at the time the transaction was made if it was made** within two **years before the petition, but insolvency is presumed if the transaction was made at any time in favour of a close relative or business associate.

Question 47

Defence of Undervalue Transaction

Answer 47

For a company, there is a defence if the transaction was entered into** in good faith, for the purpose of carrying on the business, and when it was made there were reasonable grounds** for believing it would beneft the company.

Question 48

Granting Security Not Undervalue

Answer 48

1. Granting a security interest in a company asset is not considered to be a transaction at an undervalue as this does not change the value of the company’s assets, and so does not reduce their value.
2. However, as discussed above, the grant can give rise to a** preference** which may be set aside.

Question 49

4

Fraudulent Trading

Answer 49

1. Fraudulent trading arises when a director (or any other person who knowingly participates) carries on business of the company with the intent to defraud creditors.
2. An action can be brought by a liquidator or an administrator.
3. If fraudulent trading is established, the directors may be liable to make such** personal contribution** to the company’s assets as the court orders.
4. Fraudulent trading is also a criminal offence.

Question 50

3

Wrongful Trading

Answer 50

1. Wrongful trading is a claim that at some time before a company became insolvent, the directors** knew or ought to have known** that there was **no reasonable prospect **that the company would avoid insolvency and failed to take adequate steps to minimise the losses to the company’s creditors.
2. Once a director knows or ought to know that insolvency is unavoidable, their duty shifts from what is best for the shareholders to what is best for the creditors. A wrongful trading
   action can be brought by a liquidator or administrator.
3. If the claim is successful, the court may order the director to contribute to the company’s assets as the court deems appropri-ate.

Question 51

defense of wrongful trading

Answer 51

A director can defend the action by showing they took every step with the view to minimising potential loss to the company’s creditors after becoming aware that the company had
no prospect of avoiding liquidation

Question 52

2

Setting Aside a Floating Charge

Answer 52

1. Floating charges (for example, security interests in a company’s inventory, as discussed in the chapter on raising fnance) may be voidable as a preference, as discussed above.
2. But a foating charge is automatically void—and a liquidator or administrator need not apply to court for a declaration of invalidity or an order to set the foating charge aside—if the foating charge was created:
   *For no consideration within 12 months ending with the onset of insolvency (or 2 years for a connected person); and
   *At a time the company was insolvent or became insolvent as a result if the charge was given to a person unconnected to the company. However, there is no requirement to showm insolvency if the foating charge is to a connected person.
   EXAMPLE
   A company has an unsecuredm overdraft at the bank. The bank, worried about the company’s cash fow, requires a foating charge to secure the overdraft. The company goes into liquidation 10 months later. The foating charge will be invalid and the bank will be an unsecured creditor.
   If, however, the bank had agreed to increase the overdraft limit from £100,000 to £200,000 in return for the floating charge, and the company’s overdraft was £150,000 on liqui-dation, the foating charge would be valid for the fresh consideration but not for the original overdraft. Therefore, the bank would have a foating charge in respect of £50,000 and would be an unsecured creditor for £100,000.

Question 53

Ring Fencing

Answer 53

1. A liquidator is required to set aside part of the assets subject to a floating lien for the beneft of unsecured creditors. (The assets are fguratively ringed by a fence.)
2. The amount is** 50%** of the first £10,000 in value of the property subject to foating charges and 20% on amounts above, up to a maximum ring fenced fund of £800,000.